Dear Facebook developer, if you’ve banked your livelihood on banner ad-supported applications get ready for a rude awakening. The deceptive advertising practices that have increasingly permeated Facebook applications, and driven effective CPMs on banner ad units to double-digit levels in some cases, are starting to get noticed outside of Facebook (Nick O’Neill of All Facebook has done a great job of covering this topic), which is leading to involved parties being shut down in the process. The longer-term ramifications of this put into question the business viability of many developers on Facebook’s platform.

How Did We Get Here. As recently as the 2^nd half of last year Lookery, a Facebook ad network at the time, was guaranteeing developers a mere $0.15 CPM for their application inventory. The combination of inexpensive banner ad inventory and access to Facebook users’ friends (via the social graph) was all savvy direct marketers and ad networks needed to test converting Facebook users into unknowing subscribers of mobile services (among other things) costing upwards of $20 per week. These very well integrated ad experiences that imply your friends’ usage of certain applications and services (as in these examples) are converting well enough on a an impression basis to generate upwards of $10.00 effective CPM for many large Facebook developers. Several ad networks have beem more than happy to deliver these ads since they are in turn getting paid roughly $15 to $25 CPMs by the underlying advertisers. It’s rather amazing actually that in the midst of an overall global recession that has seen the broader U.S. market indices fall around 30%, the effective CPMs Facebook application developers have received has grown upwards of 6500% over the same timeframe!

What’s Going to Happen Next. Before getting to the ‘what’ we need to understand ‘why’, which is actually quite simple- Facebook wants to go public. For this to happen, Facebook needs to show potential Wall Street investors that it has a growing, sustainable business model (so the stock price will go up) and that it runs aclean operation (so as not to make the stock price go down).

From a business perspective, among other well publicized initiatives, Facebook needs to get traditional brand advertisers to spend some of their $550 billion in global ad dollars on its platform in an effort to fuel revenue growth and justify what is sure to be a high earnings multiple it will trade at. As long as there is a perceived risk of tarnishing a brand’s image by placing ads on the same website where deceptive offerings are being run, agencies won’t allocate brand ad dollars to Facebook. In terms of its operations, investors need to feel comfortable that Facebook can effectively monitor its platform and ecosystem to avoid any potential public relation embarrassments or legal issues (privacy concerns aside) that could adversely affect the company’s profitability and trading mutiple.

In terms of the ‘what’, Facebook will become increasingly active in policing ads, networks and advertisers in their ecosystem in an effort to eradicate any potential issues that could affect the ‘why’. A prime example of this was the recent banning of ad networks Social Hour and Social Reach from advertising on Facebook applications. Facebook might even consider launching its own ad network for developers, to ensure the quality of advertisers remains high, at the expense of other ad networks.

The result of these types of actions will be a significant decrease (over 50% in many cases) in revenues seen by developers as the remaining ad networks on Facebook will have to deal with an increase in application inventory in conjunction with a decrease in advertiser demand (as deceptive advertisers are removed from the site). While I am definitely not suggesting effective CPMs will crater back to Lookery guarantee levels, like the stock market, there will be a reversion to the mean for ad prices. Regardless of where CPM rates eventually settle, there will be a flight to quality from an advertiser, as well as user, perspective. Bad experiences with certain applications will drive ad dollars and users away from applications that continue these practices, creating a death-spiral scenario in some cases (the situation where fewer users lead developers to place more ads on their applications to make-up for the lost revenue, which in turn leads to a further decrease in users due to a worse user experience, and so on).

What to Do. If you’re a developer, here are your options:

1. Stay the Course. Continue to accept these deceptive ads in an effort to make as much money as possible until these ad practices and/or networks are shut down by Facebook. If the user and/or platform backlash doesn’t kill your application business, then try one of the remaining options or follow these ads and networks to the next social platform for exploitation.
2. Go Virtual. If it makes sense, incorporate virtual goods into your applications. Game developers like Zynga have built successful businesses around the selling of virtual items to their user base, which alleviates the need for, or at least reliance on, banner ads for revenues.
3. Try Fremium. This option is more geared towards utility-based applications, but up-selling features and functions for your applications (especially if you can tether it to a service or experience outside of Facebook) makes a lot of sense since it establishes a recurring revenue stream.
4. Get Professional. Build a great application experience that makes users want to use your applications over the long-term. Work with established, reputable ad networks that have broader web reach than just Facebook applications (like Rubicon Project), inventory rep firms (like Appssavvy) or gain access to individual engagement opportunities (through the like s of my company Clearspring) to build credibility with advertisers and increase the perceived value of your applications’ ad inventory. Once you have the user base and operational scale, consider building out your own sales team (like Watercooler) to get a larger percentage of campaign CPMs.

Let’s hope Facebook application developers take the high road on this one.

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